Do stronger creditors’ rights and an efficient bankruptcy process affect the speed of adjustment to target capital structure? Evidence from a quasi-natural experiment

Abstract

This study investigates the impact of the Insolvency and Bankruptcy Code (IBC) on the capital structure speed of adjustment (SOA) of Indian firms. The IBC, introduced in 2016, significantly enhanced creditors’ rights and streamlined the bankruptcy process, providing a quasi-natural experiment to assess its influence on firms’ leverage dynamics. Utilising a panel data methodology and propensity score matching-based difference-in-differences (PSM-DID) regression; we categorise firms into over-leveraged (treatment) and under-leveraged (control) groups. Our findings reveal that the IBC significantly increased the SOA for over-leveraged firms, compelling them to reduce debt levels swiftly to avoid financial distress and bankruptcy. Conversely, under-leveraged firms exhibited a decreased SOA, reflecting a strategic shift towards financial stability over leveraging benefits. These results underscore the critical role of regulatory frameworks in shaping corporate financial strategies and align with the dynamic trade-off theory, highlighting firms’ active adjustment towards optimal capital structures. The study contributes to the literature on capital structure SOA by providing insights into how legal and institutional changes in an emerging market influence corporate financial behaviour, with significant implications for policymakers, regulators, and corporate executives.

Keywords

• Capital structure
• speed of adjustment
• bankruptcy code
• creditor right
• dynamic capital structure
• IBC